The fundamentals of Blockchain and Bitcoin

BTC: The currency everyone's heard of, many have invested in but only few understand

Unless you’ve spent the last year mutely meditating in the Tibetan plateau, chances are you've been bombarded with investment advice, opinionated articles and frantic social media posts about cryptocurrencies and blockchain technology.

Amidst all of that noise, it’s has become exceedingly difficult to form an opinion about the innovative technology that runs behind the scenes of your favorite coins and the value it could generate. With this post in the Cryptohopper blog series, we aim to clarify some of the basics of these promising technologies to aspiring crypto-traders.

Are Blockchain and Bitcoin the same thing?

If your answer to this question was anything but a resounding; “No, not really. I mean No!”, read on! Bear with us as we break down blockchain and bitcoin into bite-sized bits.

It has now been 10 years since a person (or group of people) under the pseudonym Satoshi Nakamoto created and pioneered the Blockchain. This technology now forms the backbone of the payment network for the cryptocurrency Bitcoin. By using Bitcoins, you can send transactions to other participants within the Blockchain ecosystem. Without the Blockchain ecosystem, the exchange of Bitcoins is simply not possible.

The widespread confusion surrounding the terms “Bitcoin” and “Blockchain” has come from the way people discuss them. Not least because it is easier to pronounce, “Blockchain” has become almost synonymous with “distributed ledger technology” in recent years.

Distributed ledger technology is the overarching term that describes the innovative technology according to which the Blockchain, and other systems like it, were designed. Should you hear the word “Blockchain” in conversation or in the media, it is most likely that what is actually meant is the technology behind it. While in reality, blockchain is only really the first, albeit most successful, example of distributed ledger technologies.

The same goes for Bitcoin. When people speak of Bitcoin, they often mean the market for cryptocurrencies in general. Again this is because Bitcoin had the first mover advantage and is still worth about as much as all other cryptocurrencies combined. Of course, it is also extremely famous. Ask your non-crypto friends if they know Bitcoin. Chances are, they’ve heard of it. Then ask them if they’ve ever heard of NEO and they’ll probably confirm with blissful ignorance that they have indeed seen the matrix.

What are distributed ledgers?

As the name suggests, distributed ledgers are storage databases. Think of a spreadsheet that records an informational dataset. Now imagine, that this spreadsheet was duplicated across a network of millions of computers. Each connected computer has a complete and identical view of what is stored in the spreadsheet.

Instead of a single entity managing the information of the dataset, in a distributed ledger everyone in the system has access and equal rights. That is why the Blockchain is often described as a decentralized peer-to-peer network. The database is continuously updated and each change is validated by its users, rather than some central authority.

When new information is added to the database, there is a consensus among its users that this information has been rightfully processed. Don’t worry, we’ll get to why that happens in a minute, but in a nutshell, this is why distributed ledgers get so much attention - they allow you to get rid of the middleman and create trust through transparency.

In the blockchain, every Bitcoin transaction that has ever been processed is permanently and irreversibly stored. This means no money can be double-spent, lost or tampered with. Like its founder the system relies on pseudonymity, meaning the identities of users are not directly displayed. Every user has an address that uniquely identifies them in the system.

The Mining Process & Hashes: Explained

We won’t go into too much detail about the technical intricacies, but you should know some concepts to get a basic idea.

Transactions are recorded in “blocks,” which are chronologically added to the distributed ledger. “Blocks,” created on average every 10 minutes, contain two pieces of information: (1) the details of new transactions, (2) a cryptographic “hash” connecting the new block to the previous block.

This adding of blocks occurs through the so-called “mining” process, that involves the processing of new hashes. A cryptographic “hash” is simply an abbreviation of a string of information. By decoding a hash, one could figure out the abbreviated information (e.g., a phone number containing country codes). However, in the case of Blockchain, cryptographic hashes result from complex algorithms, making them virtually impossible to unpack.

“Miners” must, therefore, solve a demanding computation denoted as a “cryptographic hashing function” for which they are rewarded through transaction fees. Any users in the system may become a miner. That’s why its competitive game. Whoever can do it the fastest can get a slice of newly created Bitcoins.

Bitcoin vs other Cryptocurrencies

Bitcoin is the currency running on the Blockchain. Unlike conventional (“fiat”) currencies, it is not backed, regulated or manipulated by any central bank. With a fixed supply, its value is mainly impacted by its scarcity and community engagement. Holders of the currency believe that the pool of buyers will increase in the future, ultimately leading the price to rise. For the time being, it is almost entirely about the speculation that Bitcoin will become a mainstream payment method down the line.

Notably, however, not all cryptocurrencies are created equal. Some do not have a limited supply while some have already reached this supply, meaning no further coins will be created. Alternatively, others may have a price linked to real-world stores of value much like a loyalty program.

Before investing, you should really do your homework to understand the differences between cryptocurrencies, their applications and how much of the currency is already in circulation. We will discuss how you can perfect this research process in our comprehensive upcoming blog post on fundamental analysis - so stay tuned!

How to get your hands on some Bitcoin

Bitcoins and other cryptocurrencies can be safely stored on private encrypted Bitcoin-wallets, hardware offline wallets or storage mediums like USB drives. The less secure option would be to have all crypto funds directly on a crypto-exchange. However, this may represent a security risk as over the years some exchanges have been found to be susceptible to cyber attacks leading some users to see their assets hacked. For more information on some of the leading exchanges and trading platforms, check out our homepage.

The first step is to make an account with a bitcoin-wallet provider, verify an account and connect a credit card to deposit funds. Once approved, account holders can use their fiat currency funds to purchase a selection of different cryptocurrencies. Some bitcoin wallets have an integrated trading platform, while others are merely used to make deposits and withdrawals.

The trading of cryptocurrencies occurs via “peer-to-peer” transactions through the exchange of private keys and verification between wallets. They are then processed and permanently stored on the Blockchain. Traders are therefore charged by the crypto-exchange to transfer assets as well as the blockchain miners to complete the transactions.

Is Bitcoin the Currency of the future?

To conclude this post, we want to address a common question many people new to the crypto space naturally pose themselves: “Will Blockchain and Bitcoin see widespread adoption?”

Only a small percentage of Bitcoin transactions are currently made in commerce, as many blockchain payment networks are still characterized by several crucial shortcomings particularly related to transaction speed. Therefore, they are still mostly regarded as an asset class rather than a currency suitable for the exchange of goods and services.

In the future, cryptocurrencies and blockchains are expected to increase efficiency and fraud protection in digital payment services, as transactions are fully traceable and can be sent seamlessly across borders.

To provide these benefits to users, the underlying technologies will have to undergo vast improvements in performance and have the ability to handle far larger transaction volumes. Further obstacles to adoption relate to the fact that there is a lot of legislative uncertainty around cryptocurrencies, which compromises investor confidence and stifles institutional investment.

Nevertheless, with 22 million Bitcoin wallets worldwide and an estimated 8% of Americans privately invested, the global adoption is already substantial. Also, the number of places now accepting cryptocurrencies as a payment method is steadily growing. Check out “Coinmap” for an interesting up-to-date view of Bitcoin’s acceptance. Paying through Bitcoin can be done either on a Bitcoin wallet app through a desktop or mobile device. You can also quickly complete phone payments by scanning a QR code.

Conclusion

This blog entry has been a brief introduction into cryptocurrencies and distributed ledgers and the origins of the technology. In the coming weeks, we will delve deeper into everything that you need to know about fundamental analysis, technical analysis, indicators as well as new developments in the space. Stay tuned for more and as always: Happy Hopping!